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NZ electricity market a 'failed experiment'

Since Rogernomics, the proponents of 'free-market' economic theories led New Zealand down the path of splitting up state-owned monopolies and privatisation with a goal to improve efficiency through competition and choice to consumers. What they have not led to is downward pressure on consumer prices or growth in those industries.

According to free market theory, when the allocation of goods and services by a free market is not efficient, it suffers from market failure. Every way one looks at it, the electricity market is a failed experiment and the government is now pursuing a path that would exponentially exacerbate those failures.

As mentioned in my previous column, there simply can't be effective competition between generators that deliver downward pressure on consumer prices. International institutions have criticised how our market works and have concluded that any generator can exercise market power.

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Economists assume that consumers will act rationally, that everyone has access to the same information, and that people will act in the best interests of those that they represent. In reality, none of those assumptions hold in the market and floating more generators on the share market will generate market volatility.

Compared to a monopoly, there is a considerably less free flow of information when there are several companies with a less diversified generation base. The profit margins are wider in order to accommodate the increased risk.

The share market introduces a new set of problems. The share price is dependent on the flow of information available to it. Rational investor behaviour would suggest that shares are bought at low prices and sold at a higher price.

The share market industry, however, relies on the irrationality of smaller 'Mummy and Daddy' investors. Mummy and Daddies get their information from alarmist news headlines and tend to buy when share prices rise and panic sell when they plunge. Institutional investors wait for such opportunities to buy low and sell high.

In short, share brokers make their fees from trades. The more volatile a market, the higher volume of trades.

Investment banks, such as Merrill Lynch, have been fined for providing less accurate to smaller investors and more accurate information to selected larger investors. Such 'insider information' can allow for short-term profits or timely exits from a market. Conversely, 'pumping and dumping' has occurred where analysts or brokers push the share price up so a favoured client can sell at a higher price.

Look at how volatile the share prices of Contact Energy and TrustPower have been over the past few months. First, there were threats to shut down the Tiwai Point Aluminium Smelter, which consumes over 10 percent of the country's electricity. The concern was that creating surplus supply would push down electricity prices. Share prices plummeted.

Then there was Labour and the Greens' announcement to make the Crown a monopsony - a single buyer of electricity - much like Pharmac does with buying medicine. Again, prices plummeted.

Such alarmist reaction demonstrates how much of a failure the electricity industry is. If there is market failure in such an essential service, a regulator should intervene where practicable. That is what Labour and the Greens are pledging.

Those who shout down Labour and the Greens' proposals, Brokers, investment bankers, and those who came up with the electricity reforms, have the most to lose if the status quo changes. Their shouting, however, has exacerbated share market volatility, and they have pocketed from it.

Electricity prices skyrocketed under Labour's charge. During that time, the Greens promoted energy conservation. The Green's policy played into the generators' hands as it reduced the pressure to build more generation. Now that Labour and the Greens are threatening intervention to benefit consumers, it exposes how silly our electricity and share markets are.

Critics of Labour and Green's monopsony fear that there would be less profit for shareholders and less investment in new generation. There is already insufficient investment in generation and there is price gouging as a result.

Labour seems to have already given up on the obvious solution. Surplus supply is essential for a competitive market, but there isn't any incentive to have surplus supply. The most efficient market structure where surplus supply is undesirable is a monopoly. Then all the generation can be allocated in its most efficient manner to deliver a consistently lower price.

If National is so pig-headed about selling off Government assets, then it should look at alternative financing options. Preferential shares, fixed interest bonds, or bank debt would work just as well. Superannuation funds, like KiwiSaver, love utilities.

Labour and the Greens would be best to pledge the monopolising of the generation market rather than the consumer market. Even after the partial privatisation by National, it would be the cheapest option that would deliver the lowest consumer prices.